We
will be away from our desk for the next month (July 12) as we prepare for and
celebrate our daughter Christine’s wedding to Gerald Wood here at the farm. Of
course if we make any trades we will post them.

June 29, 2011

June 28, 2011

We
bought more Yahoo with the Newell sale money. We switched DreamWorks which is
under pressure to General Electric to improve quality and lessen volatility.
Second tier stocks are too volatile for us to hold in a dicey market. That is a
lesson that we haven’t learned in 40 years.*****

June 27, 2011

June 24, 2011

Newell
is up a quick dollar per share in the last days. We were wondering why and
today the company announced its new CEO. We took the trade since a rise in
price on such news indicates hope not results.*****

June 21, 2011

June 20, 2011

Research
in Motion (RIMM), the maker of the Blackberry, is down $50 per share from its high this year. The shares are now
priced at 3/4ths of revenues and the price is down $10 per share in the last
week at $26. Over half the company shares have changed hands. Revenues were
actually up 16% in the quarter but will be flat to down next quarter. The
analysts who loved the stock at $60 per share say the company seems to have
lost its way. We bought a few shares in larger accounts.

The past week's events have
certainly been scary for investors in Research In Motion (RIMM). With
headlines declaring that "RIM Is Finished"
and "Wheels Coming Off at Research At
Motion," you'd think the company was on the verge
bankruptcy, especially in light of the fact that RIM received at least six downgrades from Wall Street's
typically optimistic analysts. In fact, according to
the Toronto Globe
& Mail, RIM's situation is so dire that it is putting the
entire "Canadian technology 'ecosystem' at risk." All this doom and
gloom originated from a single bad set of quarterly (pdf)
results.

To be fair, it was a pretty
lousy quarter for the company. While revenues were up 16% year-over-year (Y/Y)
and Q1 earnings beat expectations, revenues were light versus expectations, and
RIM sharply lowered its outlook for the next quarter and full-year fiscal 2012.
RIM's growth appears to have stagnated with revenue expected to fall slightly
in the upcoming quarter. Furthermore, RIM's new PlayBook tablet is struggling
to make a dent in Apple's (AAPL)
market share. Certainly, the market is correctly interpreting this press
release as very bad news.

That said, the market has, in
its usual herd-like fashion, greatly overreacted. Analysts are already writing
obituaries comparing RIM to other fallen phone manufacturers such as Nokia (NOK) and Palm.
But RIM isn't dead yet, in fact, its balance sheet is downright vibrant.
According to the company's latest press release, it has more than $2 billion of
cash and short-term investments. Its operations generated nearly a billion
dollars of cash last quarter alone. The company has no debt whatsoever to
offset against this mountain of cash.

The company also remains
wildly profitable. It anticipates making between $5.25 and $6 a share in fiscal
year 2012, giving the company a forward P/E of 5. Even companies thought to be
in dying industries, such as newspapers, typically trade at higher P/E ratios.
For a company in a dynamic industry such as technology, a forward P/E of 5 is
insanely cheap.

RIM also benefits from having
a very clean balance sheet with very little accounting risk. The company has
very little in the way of goodwill or other other soft assets on its balance
sheet that could get written down. The company has no debt, and accounts receivables
have been falling as well. Without any other obligations to hinder it, RIM has
free reign to aggressively repurchase shares. It just announced another buyback
that will repurchase up to 5% of the float.

No one is arguing that RIM's
management has made the best moves in the past quarters. Clearly the company
has lost its edge. Management has failed to adequately address investors'
concerns. But all is not lost. The company still has a dominant brand, an
enviable balance sheet and cash position, and the resources and capability to
mount a turnaround. And with other weaker phone players falling by the wayside,
RIM should be able to maintain market share even if it loses more ground to
Apple and Google (GOOG).
And, unlike its domestic markets, RIM's international growth remains strong --
year over year international revenues rose 67% in the most recent quarter.

While RIM's earnings and
revenues will not be able to grow significantly for the foreseeable future, the
business isn't dying. If revenues merely stabilize at present levels, the
company's shares will represent a compelling value. With a P/E in the 5s and a
continuous buyback program, RIM will be able to dramatically shrink its float.
And if Apple or Google should face a technological setback of their own, RIM
may be again be able to become a growth-oriented company. With billions of
dollars of cash on the balance sheet, RIM has time to refocus its R&D.
While stagnant sales and revenue are not desirable, RIM is not in a race
against the clock, it has plenty of resources to withstand current competition
while designing new products that can revive the BlackBerry brand's vitality.

While RIM shares could
certainly still fall more before hitting bottom, particularly if Wall Street
continues to hurl more negative rhetoric at the company, the future should be
bright for RIM shareholders. The RIM story is far from finished. The company
has had a rough transition from being a growth-oriented stock to a value stock,
but following last week's carnage, it has finally finished the transformation
and become a true bargain. With RIM's tremendous operating cash flow and share
repurchasing program, investors have a large margin of safety. Unless RIM's
brand, patents, and R&D program have virtually no value, RIM shares should
rebound from current depressed levels.*****

June 17, 2011

June 16, 2011

We
switched Goldman and Fifth Third to the SPDR Financial (XLF). We don’t have the
fortitude to continue to hold individual names through this correction. The XLF
has performed in line with both of these issues- actually XLF is down more in
the last month on a percentage basis. The financials are undervalued but like
Ford they seem to be getting more undervalued. Owing the ETF we don’t have to
go through the agony of individual names in the news.

We
also sold the large Bank ETF because of our now substantial position in XLF.

Finally,
we don’t think the correction is over but the accounts are situated as we would
like for any further down trend. Corrections need to be painful in order to
work and this one is providing plenty of pain for us. It will be over when it
is over and there is nothing we can do about it. Mr./Mrs. Market follows his/her
own agenda. We do think the negativity is overblown but everyone in politics,
finance and the media is talking his/her own book and negativity sells so we
expect no less.*****

This is Quadruple Witching week
and also Quarter end approaches and we think that is the reason for the extra
pressure on Cisco and Hewlett and most of the value names we own. Many entities
don’t want to own these names which have performed miserably this quarter for
their 6 month of one year fiscal year reports.
*****

We
added Medtronic and Newell to accounts.

Medtronic
dropped from $43 to $38 in the last month on disappointing earnings. Analysts
still expect it to earn $3.40 this fiscal year and JNJ just exited the coated
stent business so there are only three left; MDT, St. Jude and Boston
Scientific.

Newell
dropped from $20 to $14 in the last two weeks on lowered but still higher than
last year earning’s expectations which remain at $1.40 for the fiscal year.

June 15, 2011

The Alibaba/Alipay brouhaha at Yahoo has settled down and
the share price is 10% below our exit of a few weeks ago. We are beginning to
repurchase shares in accounts with room for more.*****

We also have continued to add Goldman Sachs to accounts.
They are crooks but we are not going to beat our heads against the wall. If the
people they trade with and take advantage of don’t know by now that Goldman
considers the customers the suckers we have no sympathy. One analyst suggested
that with the new financial rules Goldman won’t be able to make money like they
did a few years ago. Where there is a will there is a way and with Goldman
there has always been the will to find a way.*****

Cisco became a technology
powerhouse by using a tried and true business strategy; roll-up your
competitors until you own enough market share to preserve your pricing power.
Cisco combined great products and great relationships with its “channel
partners,” and then was further helped when the bursting of the tech bubble
wiped out much of the weaker competition. Cisco was so effective that they
controlled well over 50% of the router market and over 70% of the switch market
at its peak. Any company printing as much cash as Cisco does (about $10 billion
annually) becomes a target of competitors. When companies began rebuilding data
centers and communications networks, Cisco’s competition was provided the
opportunity they were waiting for to dethrone the king. To the credit of its
competitors, Cisco was distracted by unnecessary bureaucracy, its entry into an
unattractive consumer business, and the integration of the many different parts
of a communications network into one super-duper computing system (called UCS).
This allowed competitors to catch Cisco unaware when they slashed prices on
lower cost products that may not have been “best-in-class” but were good enough
thanks to Moore’s Law. Accentuating Cisco’s problems is that many of its new
products are so innovative that they cost significantly more to make than
previous versions and will carry lower margins as volumes build. So CSCO may
have lost a few points of share, but we are still talking about numbers around
40% in routers and 60% in switches.

In my view the issue with
Cisco is not its R&D budget or lack of innovation. The company has spent
$24 billion in R&D over the last 5 years and created some of the most
technologically advanced products on the planet. The amount of money a company
spends on R&D doesn’t mean much if you can’t produce a product (Pfizer (PFE) spent $41 billion over the last 5 years with
nothing to show for it) but Cisco has the cutting edge technology that
corporate, data center, and service provider customers want and need. In fact
Cisco’s “New Products” (some of which were acquired) grew sales by 15% last
year to $3.2 billion. As the world increases the amount of data and content it
collects, analyzes, and shares, Cisco products continue to make that possible
at faster and faster speeds. I can’t think of another company with an offering
as broad or as deep. Not all of those products are winners, but many of them
are. I recently had a conversation with my company’s datacenter provider who
said that:

“Cisco’s unified server (UCS)
is years ahead of the competition. Their switches and routers, integrated into
their blade server, makes the network unbelievably fast. The future of
technology is all about the network, and Cisco has built a better, faster,
network.”

is only one view, and stopping
there creates the potential for confirmation bias in decision making, but it
does show that people who make their living collecting and managing data have
some pretty good things to say about Cisco’s products. So Cisco’s problems are
less about innovation and more about sales, pricing, and market acceptance of
its technology.

The primary risk to the stock
is the company's changing relationship with its Channel Partners, which account
for 80% of Cisco’s sales, as the company positions for the future. Channel
Partners are the IT consultants at IBM (IBM), Accenture (ACN),
and Hewlett-Packard (HPQ) that are designing and implementing these
datacenter upgrades, and are primarily responsible for the high demand for
Cisco’s products. These consultants build the network, and the equipment makers
cede the service revenue to the consultants to keep them happy. This is the key
to NetApp’s (NTAP) success. NetApp has excellent
products, but is willing to leave service revenue on the table for their channel
partners, while EMC Corp. (EMC)
goes direct to the customer and often steps on the toes of the channel
partners. So, you can see NetApp is basically employing Cisco’s business model
to the data storage business. When Cisco announced that it was selling its own
server with integrated switches and routers (called UCS), this severely damaged
its relationship with HP, which was both a channel partner and a server maker.
As Cisco ventures deeper into its strategy of rolling up the datacenter into
one machine, it also stands to reduce some of the design and service revenue
that previously went to its partners. Cisco’s Acadia Joint Venture with VMWare
(VMW)
and EMC, headed by Michael Capellas, is further evidence of this strategy, as
it incorporates a software component into the unified hardware, biting deeper
into the revenue of its partners.

In the most recent quarter,
Cisco’s service revenue grew by 14% to over $2 billion, and I have to assume
that is revenue that the company previously left on the table for its partners.
I can’t help but wonder if the recent report from Gartner Consulting --
condemning Cisco’s unified strategy in favor of a multi-vendor dissociated
approach -- was a brush back pitch from the consulting industry that is
increasingly concerned about a serious competitor with cutting edge technology
that is crowding their revenue plate. So it is concerning that Cisco is
increasingly positioning itself to compete against its channel partners, but it
has chosen the very best partner with which to wage this battle in VMWare (85%
owned by EMC). VMWare is the leading virtualization software maker, and while
most of its revenue has come from making servers more efficient, virtual
switches and virtual routers will play a bigger role in the future. The
marriage of virtual software with excellent hardware has been a “killer app” in
the datacenter, and Cisco has wisely locked into a partnership that will extend
and enhance its leadership position.

It appears that Cisco is not
complacent, and is even preparing for a more protracted battle with its sales
force in order to create the products of tomorrow and protect its market
position. The company has moved beyond just selling hardware and has ventured
into collaboration software and hardware consolidation in preparation for the
future. Did the company strike-out on the consumer venture? Yes. Is Cisco being
challenged by formidable competitors who are seizing the opportunity created by
IT infrastructure spending cycle? Yes. Are the fiscal problems of governments
around the world (23% of revenue) negatively impacting results? Absolutely. It
is also true that if Apple and Google (GOOG) attempt to eliminate your cable
box (and bill?), Cisco could be negatively impacted (as would Broadcom (BRCM)) because they have aligned
themselves with the service providers in the battle for the living room.
However, by most accounts (Gartner included) Cisco has some of the best
technology in the business. So let’s not group them in with Microsoft (MSFT) just yet. Cisco appears so
confident about its technology that it is positioning to do battle with its
channel partners, who become less necessary as Cisco rolls up the datacenter
into a one-stop-shop. This is sure to be a volatile ride as the battle plays
out in real time, and I would not be surprised to see Cisco dig into its very
deep coffers to acquire VMWare and entrench its leadership position. The future
of technology is all about the network, and the ability to securely access and
collaborate wherever you want, whenever you want, and Cisco continues to
dominate this market. Many interested parties have a vested interest in Cisco
getting taken down a peg, but the company is not dead. Far from it.

June 13, 2011

This
article doesn’t make our losses any more palatable but it does add perspective.
All three are known as value managers- as are we:

Berkowitz Leads Stock Pickers Hitting Bottom

Bruce Berkowitz, Kenneth Heebner and Bill Miller, three of the best-known
U.S. stock pickers, are competing for last place this year after their bets on
an economic expansion backfired.

Funds run by Berkowitz of
Fairholme Capital Management LLC, Heebner of Capital Growth Management LP and
Miller of Legg
Mason Inc. (LM) are the three worst performers among large
diversified U.S. mutual funds in 2011, according to data from Chicago-based Morningstar Inc.
The funds lost 11 percent to 12 percent through June 9, compared with a gain of
3.4 percent for the Standard & Poor’s 500 Index.

“People assume because certain
managers have had good streaks that they are always going to be a step ahead of
the market,” Russel Kinnel, director of mutual fund research at Morningstar,
said in a telephone interview. “It never works out that way.”

The three managers are known
for concentrating money in a small number of industries, said Kinnel, a
strategy that can produce market-beating gains when the investments work out
and large losses when they fail. Berkowitz, Morningstar’s fund manager of the
decade, and Miller, known for beating the S&P 500 for 15 straight years
through 2005, are wagering on a rebound in financial stocks. Heebner, manager
of the best-performing diversified U.S. stock fund over a 10-year period until
this year, was betting on automakers.

The two industries are the
worst performers this year in the S&P 500 out of 24 groups. Bank stocks, as
measured by the KBW
Bank Index (BKX), fell 10 percent on concerns that the
housing slump, litigation over mortgage bonds and foreclosures and new
fee-crimping rules will depress bank earnings.

Betting on Banks

Berkowitz’s $14.8 billion
Fairholme Fund had 74 percent of its equity holdings in financial stocks as of
Feb 28, Morningstar data show. The fund fell 12 percent through June 9, ranking
it last among 870 diversified U.S. stock funds with at least $500 million in
assets.

Berkowitz didn’t respond to a
request for comment. In a June 9 interview, Berkowitz said he was “more
certain” than ever that his investments in financials made sense.

“The trends are getting
better,” he said in the interview with Bloomberg Television’s Erik Schatzker.
“The balance sheets are getting better and the cash flow is there to take care of the
problems.”

Berkowitz said Brian Moynihan,
chief executive officer of Bank of America, was doing “a good job” and that the
bank “was making all the right moves.” Bank of America, based in Charlotte,
North Carolina, fell 19 percent this year, including dividends.

Heebner, manager of the $2.5
billion CGM
Focus Fund (CGMFX), didn’t fare better, losing 12 percent
through June 9, second-worst among large funds, according to Morningstar. His
fund had 36 percent in auto stocks at the end of 2010, according to a
regulatory filing.

Heebner, 70, is known for
making concentrated bets in industries from homebuilding to commodities and for
his willingness to shift gears quickly. CGM Focus Fund, which gained 80 percent
in 2007, returned 12 percent a year for the past 10 years, better than 99
percent of rivals.

“We anticipate a better
domestic economic environment in the year ahead,” Heebner wrote in a Jan. 3
letter in the fund’s annual report.

Signs of Slowdown

Those expectations were damped
when the U.S. economy
slowed to a 1.8 percent annual rate of growth in the first quarter, from 3.1
percent gain in the final three months of 2010.

More recent reports suggest
the world’s largest economy is slowing further. Manufacturing grew at its
slowest pace in more than a year in May, consumer spending rose less than
forecast in April, and the unemployment rate unexpectedly climbed to 9.1
percent in May.

Investors make a mistake when
they judge stock pickers only on short-term performance, said Kinnel.

“Managers don’t go from
geniuses to idiots overnight,” he said. “Some of the investments they have made
may well pay off.”

‘Short-Term Adversity’

Berkowitz, 53, was named
Morningstar’s domestic stock manager of the decade in January 2010. His fund,
which opened in December 1999, has beaten the S&P 500 Index every year but
one, 2003, according to data compiled by Bloomberg.

“Berkowitz hasn’t had a bad
period of investment returns since the beginning,” Steven Roge, a portfolio
manager with Bohemia, New York-based R.W. Roge & Co., said in a telephone
interview. “It will be interesting to see how he overcomes this short-term
adversity.”

“Berkowitz may be right, but I
thought it was prudent to reduce our concentration in the distressed financial
sector,” Sugameli said in a telephone interview from Wellesley, Massachusetts.

Investors pulled $2.3 billion
from Fairholme
Fund (FAIRX) in April and May, according to Denver-based
Lipper. The fund attracted deposits of $11 billion in the four years ended Dec.
31.

Miller’s $1.5 billion Legg
Mason Capital Management Opportunity Fund lost 11 percent through June 9,
third-worst among large funds, Morningstar data show. The fund had 36 percent
in financial shares at March 31.

In an April letter to
shareholders, Miller wrote that the first quarter was a good one, “for almost
everyone except us.” He said technology, health care and financial stocks were
attractive. Miller, 61, declined to comment for this story, Maria Rosati, a
spokeswoman for Legg Mason, wrote in an e-mail.

Miller is best known for
beating the S&P 500 for a record 15 straight years through 2005 with his
larger Legg Mason Capital Management Value Trust. The fund trailed the U.S.
benchmark for the next three years as Miller underestimated the severity of the
financial crisis and his bets on banks and real- estate companies backfired.

The Dow is now up only 3.2%
year to date and the correction since the May 2 high at 12,876 is 7.2%. The
NASDAQ, Dow Transports, Russell 2000 and Philadelphia Semiconductor Index (SOX)
are in the red year to date with these averages down 8.4% to 10.6% since their
May 2 highs, which takes the pullback into correction territory.*****

The success of the recent oil
auctions in Iraq is creating a windfall for American oil services companies.
Schlumberger (SLB),
Baker Hughes (BHI), Weatherford (WFT), and Halliburton (HAL) have committed to drilling
2,500-3,000 new wells per year and building new pipeline and shipping terminal
infrastructure that could make the country the world’s largest oil exporter.

The value of these contracts
may reach a massive $60 billion over the next six years, and could generate $1
billion in new revenues for each company per year. Two offshore terminals are
already under construction, and another two are on the drawing board. If
successful, the project will boost the country’s oil production from the
current 2.5 million barrels a day to 12 million b/d by 2016.

Iraq’s oil production peaked
at 3 million b/d in 1979, and then went to nearly zero after it invaded Iran. I
remember those days well, as I was issued a visa to accompany Saddam’s troops
to Tehran, only to see it canceled when the Iranians were able to mount a
counter offensive. I still have the dessert camos and telephoto lenses need to
cover the desert war, although the pants, regrettably, no longer fit. Iraq’s
oil industry never recovered.

UN sanctions limited the
regime to minimal “official” exports that covered humanitarian imports like
baby food and drugs. Tanker trucks smuggled out through Jordan what they could,
with the proceeds going directly to Saddam’s family. When the US invaded, bails
of hundred dollar bills were found stashed in private homes, the proceeds of
these black market deals.

American oil engineers were
shocked by the poor state of Iraq’s energy infrastructure after 40 years of
neglect. It all has to be rebuilt from scratch. If the new Iraqi government can
provide the necessary infrastructure, and stabilize the political and security
environment, it will become one of the largest changes to the landscape for
international trade in decades. Those are all very big “ifs." It will dump
another Saudi Arabia’s worth of crude on the market.

It will also go a long way
toward meeting China’s insatiable demand for oil, and put a long term cap on
prices. Of course, this is the scenario that antiwar activists predicted eight
years ago, but no one else, especially the Bush administration, thought it
would take so long to play out. This is so important that I can’t believe no
one else is talking about it.*****

June 10, 2011

We
sold Dell, Nvdia, BP, Morgan Stanley and The Gap. All are recent purchases and
with the failure of the bounce of yesterday we would rather have the cash on
hand. We have made money trading NVDA, BP and DELL this year but this time we
had losses on the trades; 10% on the NVDA; BP was a 3% loss; and the Dell less
than 2%. The Gap and Morgan Stanley were minimal losses.

The
present pain will eventually lead to gain, keep the
faith.*****

June 9, 2011

June 8, 2011

We
switched BankAmerica to the Financial Services ETF (XLF). We did this to
moderate the downside if the financial sell off turns into a route while still
maintaining exposure. Both issues are down about the same percentage in the
last month but BAC is down twice as much a percentage for the year. We want
participation in the beaten down financials but given market sentiments a
diversified list will give us that participation. We do sacrifice some upside
but at this point riding out the downside (any being comfortable adding to the
position) to participate in the eventual upside is our primary consideration.

Stocks are no longer
overvalued, but they are not undervalued enough to buy aggressively:

On February 18 we had a
ValuEngine Valuation Warning with more than 65% of all stocks being overvalued;
all 16 sectors were overvalued, most by double-digit percentages.

On May 2 we had a ValuEngine
Valuation Watch with more than 60% of all stocks being overvalued; all 16
sectors were overvalued, most by double-digit percentages.

Today, June 8 only 43.5% of
all stocks are overvalued therefore 56.5% are undervalued. Only five of 16
sectors are overvalued with Multi Sector Conglomerates 14.8% overvalued.

Ford Accelerates Dramatic Global Growth

Five years into the Alan
Mulally era at Ford
(F), the automaker is shifting its focus from its U.S.
turnaround to dramatic international growth.

"We have the foundation
now to serve a much wider range of customers worldwide," said CEO Alan Mulally,
concluding a three-hour investor day presentation Tuesday afternoon.

At the start of the
conference, Mulally noted "we've been working toward this day for five
years," and he welcomed the chance to talk about "where is Ford going
in the longer run."

Later, Mulally, who is 65,
parried an analyst's question about how long he will stay with Ford. "I
absolutely am honored to be serving Ford, and I look forward to helping to
accelerate the implementation of this plan," he said.

Shifting to a global focus
is not a new concept for Ford; it has been a theme for more than a year. It is,
in fact, a necessity because Ford so badly trails rivals in the key Asian
markets of China and India.

But on Tuesday, for the first
time, Ford attached numbers to its growth intentions. Among them, by mid-decade
the automaker wants to increase worldwide sales by about 50% to about 8 million
vehicles, up from 5.3 million in 2010.

By 2020, Ford wants small
vehicles to represent about 55% of sales, up from 48% today. About 32% of its
sales would come from the Asia Pacific and Africa, more than doubling its
current percentage of sales from the region.

In terms of margin, Ford said
it wants mid-decade global automotive operating margins to increase the 8% to
9% range, from 6.1% in 2010, while North American operating margin in the 8% to
10% range. Additionally, Ford's debt reduction efforts will continue, taking
automotive debt to about $10 billion, down from $16.6 billion at the end of the
first quarter.

The key to growth in China and
India is for Ford to expand its limited product
offering. By 2015, Ford would expand its China line from five
to 15 products and its India line from three to eight products. In India, for
instance, Ford increased sales by 3% by adding a single product, the Figo. In
China, Ford currently has about a 4% market share, while General Motors (GM) has about a 14% share.

The good news is rapid growth
in the entire China auto market, and Ford's plan to increase its product mix so
it is not just in the larger car market when most Chinese consumers are buying
smaller cars. Ford said it can reduce prices in emerging markets by creating
lower-priced versions of global vehicles.

June 7, 2011

We
also bought Talbots down $1.70 (40%) to $2.70 after sales missed by $5 million
and going forward outlook disappointed. At $2.72 the share price is suggesting going
out of business. We have a long term highly speculative and now almost
worthless position in the warrants.

The
question with Talbots at this price is will they survive. We think they will
but …..

Talbots
and Ford have been the reason we have underperformed the market this year. In
time we will recoup in Ford but Talbots stands right up there beside Unisys as
a stock we wish we had never considered. Given where the shares are priced and
that TLB earned money in the quarter we are not surrendering hope. But hope is
just that and not and investment measure. Are the shares worth the risk? We
tend to think so but we have a warrant position which can’t go down any more
and we bought a few shares of common in aggressive and younger folk’s accounts
or very large accounts in a very small percent of total assets. The company
will both survive and be a grand slam or a strike out.*****

June 3, 2011

June 2, 2011

We
added The Gap to accounts and also added to our position in BankAmerica.*****

Market
corrections are painful over the short term. The more pain they inflict; the
better they work. If they are too painful- stop watching- we are paid to watch.
Market corrections offer opportunity.*****

(WSJ) In the U.S., auto makers
sold around 1.09 million cars and trucks last month, down from 1.1 million a
year ago, General Motors Co. estimated. On a seasonally adjusted basis,
annualized U.S. sales for the month were 12 million, down from 13.2 million
vehicles last month but up from 11.6 million a year ago.

GM sales fell 1%, to 221,192
vehicles compared to 223,410 a year ago. Ford
Motor Co. said its May U.S. sales declined less than 1% to 192,102
as the discontinuation of its Mercury brand depressed total volumes. Chrysler's
sales rose 10% to 115,363 vehicles, largely on a 55% gain for its Jeep brand.

Nissan
Motor Co. said its sales declined 9.1% in May to 76,148 units versus
83,764 units a year earlier. Honda
Motor Co. and Toyota
Motor Corp. also are expected to report declines later Wednesday.

Last month marked just the
second time in 18 months the U.S. auto industry reported a significant decline
in monthly sales from the year-earlier period. The prior time was August 2010,
when sales from the year before were boosted by the government's "cash for
clunkers" scrappage program.

Auto makers pulled back
dramatically on discount spending for the month. Japan's car companies backed
off discounts as they struggled to meet demand in the wake of the March
earthquake that crippled many auto plants there. U.S.-based rivals, meantime,
limited deals in line with their competitors.

The total transaction price
for the average vehicle sold last month in the U.S. rose 2.1% to $29,817, the
highest ever recorded, according to pricing researcher TrueCar.com.

…..At GM, sales of passenger
cars climbed 13% on the continued strength of its compact Cruze, along with the
Buick Regal and Cadillac CTS. However, its full-size pickup-truck sales fell
14% over a year ago.

Month-end dealer inventory in the U.S. stood at
about 584,000 units, up 7,000 from April and 177,000 from the year-earlier
month.

Ford, meanwhile, boosted its production forecast
for the third quarter saying it will produce 630,000 vehicles in its North
American assembly plants, up 44,000 vehicles, or 8%, compared with the third
quarter of 2010.

In the second quarter, Ford plans to produce
710,000 vehicles, unchanged from a previous forecast, but up 57,000 vehicles
from the second quarter of 2010.

May had 24 selling days, two fewer than last
year.

Cisco: An Attractive Investment Is Hiding in the Dark Shadow of Stock
Performance

Markets are efficient, or so
we’ve been told. I am not here to put a rebuttal to this academic nonsense, but
let me give you one of the core reasons why markets are and will remain
inefficient: because human beings are efficient.

To function in everyday life,
our brains are used to simplifying complex problems, through pattern
recognition. We become accustomed to drawing straight lines when we see two
points, and if we get a third or fourth point that fits the line, our
confidence about the longevity (continuity) of the line increases
exponentially. We become excited, even certain, about prospects of the company
we’ve invested in when its stock has gone up for a long period of time, while
we often dismiss stocks that have declined or flat-lined, especially if that happened
for a considerable period of time.

Imagine an analyst bringing a
“fresh” stock idea to a portfolio manager at a large mutual fund. He’d say
something along these lines: Cisco (CSCO) is a buy, it has a bulletproof
balance sheet with $25 billion of net cash (cash less debt), the stock is cheap
– trading at 9 times earnings (excluding net cash), it’s providing double-digit
returns on capital, and it is a dominant player in the industry, which is
poised to grow at a faster rate than the economy, since, thanks to iPads (AAPL), Androids (GOOG), Kindles (AMZN), Hulus, and Netflixes (NFLX), we’ll all continue to consume
digital content.

I can just see the portfolio
manager’s smile, his laugh and comment that “This stock is a value trap, it has
gone nowhere in more than a decade.” I’m glad I’m not that analyst, as I’d have
a huge burden to overcome. After all, Cisco has shattered the dot-com dreams of
many investors in the years following 1999, when it hit $80 a share and, for a
brief moment, was one of the most valuable companies in the world, sporting a
modest P/E of 100+. Since then, gravity has caught up with Cisco’s stock (it
always does), and it has declined almost 80% from its highs, to $17. Most
investors who bought the stock since ’99 either lost or made no money. Draw a
straight line through its chart (you have more than a decade’s worth of data
points), and you see it’s either going to zero or at least will continue to go
nowhere. Now, you add to this performance a few quarters of disappointing Wall
Street guidance, and you have an untouchable, un-recommendable stock.

However, fundamentals – take
any metric: revenues, earnings, cash flows – will tell a very different story:
They either tripled or quadrupled since 1999. Through no fault of its own,
Cisco’s stock was too expensive in 1999, and it took time for the stock to
catch up to its fundamentals. Of course, as usually happens, investors get
overexcited on both sides of valuation. The same investors who could not get
enough of Cisco at over 100 times a little more than decade ago, don’t want
touch it at 9 times earnings with a 10-foot pole. (Here is efficient market for
you.) The dark shadow of the stock performance hides an attractive
investment.

Cisco is not a spring chicken
anymore; it has over $40 billion in sales. It will likely see some margin
compression as parts of its business mature. Its revenue and earnings will grow
at a slower rate than they did over the last decade. But at its current price
Cisco doesn’t have to do anything heroic to justify its valuation, it just
needs to show that it has a pulse.

It is very difficult to get a
unique insight into Cisco’s business or that of any large-cap stock; after all,
they are followed by a small army of analysts (Cisco is followed by some 40
analysts). Some sell-side analysts undoubtedly know what John Chambers’
(Cisco’s CEO) favorite cereal is, and can recite the model number
of every Cisco router by heart. Most of us cannot compete with that, nor do we
need to.

First of all, you need to have
a time horizon longer than Wall Street’s. Wall Street is very
short-term-oriented, and mutual fund managers are judged and compensated on
their monthly and quarterly performance. Sell-side analysts are there to serve
their buy-side masters, and thus expend their energy analyzing the next
quarter, not the next five years. Therefore a time horizon longer than Wall
Street is significant competitive advantage in itself. Cisco’s earnings three,
five years from now are likely to be significantly higher than they are today.

It is also important to
understand that even a much-followed stock like Cisco will suffer from
inefficiency (which as a value investor I welcome), due to investors confusing
the lousy stock with the company’s fundamental performance. That is how you
find high-quality companies at bargain-basement prices.

Understanding what happened in
the past is important, not because it is the precursor to the future, but
because it helps to build the analytical bridge, through our own analysis, from
today into the future. Be inefficient – don’t draw straight lines.

For Hong Kong’s population,
trading in complex financial products rivals a day at the track. Despite the
territory’s tiny size, its market for “exchange-traded warrants” is the most
active in the world. Last year’s turnover of $534 billion put it far ahead of
South Korea and Germany, the next biggest. The instruments give investors the
right to buy a security at a fixed price, allowing them to bet on which way a
market will move or to arbitrage differences between the warrant and its components.

Almost 14,400 such products
were issued in Hong Kong last year by a dozen or so big banks, each with a
prospectus the size of a phone book that must be approved by the exchange’s
listing committee and incurs a registration fee of HK$100,000 ($13,000). Given
the warrants’ complexity, problems can emerge. Few cases will excite more
Schadenfreude than that involving Goldman Sachs.

On February 11th Goldman
issued four warrants tied to Japan’s Nikkei index which were described in three
separate filings amounting to several hundred pages. Buried in the instructions
to determine the settlement price was a formula that read “(Closing Level –
Strike Level) x Index Currency Amount x Exchange Rate”. It is Goldman’s
contention that rather than multiplying the currency amount by the exchange
rate, it should have divided by the exchange rate. Oops.

The mistake meant that the
warrant should have had a much higher price than that quoted by Goldman.
According to a report compiled for Hong Kong’s legislature, the exchange was
notified at 9.10am on March 31st by a lawyer for Goldman that an error had been
made and quotes would be suspended. At 9.40am, just after the opening of
trading, the exchange began receiving complaints from traders who wanted to buy
in. By 10.52am, with prices spiking and after a request from Goldman, the
exchange suspended trading. The notes have been frozen ever since.

Goldman has made an offer to
buy back the warrants from holders for a 10% premium on their purchase price,
plus a fixed payment to cover broker fees. In resisting a settlement tied to
the published formula, Goldman cites a clause in the prospectus that lets an
issuer change terms “of a formal, minor or technical nature, which is made to
correct an obvious error”.

This argument has not won over
the 124 warrant-holders. Based on the formula provided in the prospectus, says
one of them, Goldman could be on the hook for HK$350m, as opposed to the
estimated HK$10m being offered. The bank’s offer has already been extended once
because of lackluster response. Holders also allege that after it notified the
exchange of the problem but before trading was frozen, Goldman continued to bid
to buy back the warrants while ceasing sell offers that would have meant
disclosing the real price based on the prospectus. Goldman merely says it made
offers at the “correct” price.

There are wider issues at
stake. Warrant-holders slam the Hong Kong exchange, not just for approving the
prospectus but for treading softly around an important, and profitable, client.
(The exchange has launched an investigation of its own.) Politicians are taking
an interest. “If it was possible to renege even on what was written down in
black and white, how can we possibly be an international financial centre any
more?” asked James To, a member of the Legislative Council (Legco), at a
hearing in April; another Legco hearing was held this week and a further one is
due in June. Perhaps the biggest question of all concerns the complexity of
these instruments. What other risks might be lurking in the market undergrowth?
*****

We plan on being in business for at least the next twenty years
and with this in mind we are changing the frequency and content of our internet posts. We will maintain our
concentration on market activity while we simplify our business day. We have been writing about the markets
for 27 years - on a daily basis for 12 years - and giving investment advice for 45 years. Our guess is that
while we haven’t seen and said it all we are pretty close to having exhausted any new words of wisdom
we might wish to convey. Markets don’t repeat but they do rhyme. By not posting dally we will be
freed up to do some summer/winter activities such as gardening/snowshoeing, riding our horses,
walking the dogs and spending a bit more time with the prince and princess when they visit. And
so we are going to end our lengthy daily comments but we will continue to post periodically when
market events warrant and/or when there is activity in the Model Portfolio.
*****

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